Assume that you are the manager of a small European firm that sells nails in a competitive European market (the nails you sell are a standardized commodity; the points of sales view your nails a identical to those available from other firms). You are concerned by a recent trade publication highlighting that the overall Market Supply of The Nails will decrease by 2 percent, due to the exit by foreign competitors. Also, due to a growing EU economy, the overall market demand for nails will increase by 2 percent.
A perfectly competitive market has particular characteristics, such as no barriers to entry, identical products and symmetry of information. Because of these characteristics, the firms in the market are price takers rather than the price makers. Also, marginal revenue, price, and average revenue are the same. It suggests that to increase profit, 1) the firms have to expand their production of nails and 2) reduce the marginal cost of production. Economists also presume that when demand increases, during the short run, competitive firms, which are operating in competitive markets, can earn an unusual profit. For instance, when the demand shifts to the right (demand shifts because of the exogenous factors), competitive firms earn a profit.
As per the information given, the trade publication has projected that demand for nails will increase (shift to the right) and supply will decrease (shift to the left). It will produce an opportunity to earn more for the nail producing firm, which products are standardized. The increase in demand is estimated to be two percent (2%), whereas the increase in the supply is also projected to be two percent. It implies that a probable increase in the profit will be around 4%.
It is evident from graph (a) that the increase in demand is equal to the decrease in supply, which has not affected the output; however, it has affected prices. The increase in the price is a consequence of a shift in demand and supply curves in the opposite directions. During this short run, the European firm will earn an abnormal economic profit. It will attract more firms to the market, which will reduce prices and profit. In the long – run, competitive firms only earn a normal economic profit (Samuelson and Nordhaus). (Note: Generally, competitive markets are considered hypothetical markets, as in no market standardized or identical products are sold.)
Work Cited
Samuelson, Paul A and William Nordhaus. Economics. Tata McGraw-Hill Education, 2010.
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